A delightfully entertaining drama is playing out these days.
This one features several of Wall Street's heaviest hitters -
, George Soros, Daniel Loeb, and Bill Ackman.
The drama centers on
, a nutrition company that sells products through a network of
individuals who serve as resellers.
It all started when one of the best performing hedge fund
managers started publicly bashing the stock. That investment
manager is Bill Ackman of Pershing Square Capital.
Pershing Square began shorting-selling Herbalife shares in May
2012. Short-selling is an investment bet that a company's shares
will drop in price. Though Ackman hasn't disclosed his average
sale price, Herbalife shares were trading around $45 when he
started short-selling the stock.
What we do know is that Pershing Square has amassed a
20-million-share short position. That's a sizeable position, and
equals nearly 19% of Herbalife's outstanding shares. In December,
Ackman went public with his position. And he started touring the
media circuit, sharing his view that Herbalife was an
unsustainable pyramid scheme.
Big-name investors are motivated to tell the world about their
deeds. By sharing their positions, their stocks frequently pop.
Shortly after Ackman promoted his short position, Herbalife
shares dropped to the mid-20s.
But shorting a company and then promoting that short is risky
business. The big risk to a short-seller like Akman is the
dreaded short squeeze.
Short squeezes can occur in a heavily shorted stock. If there
is increased buying of the stock, the share price rises.
But with a large number of shares tied up by short sellers, the
price can rise very quickly.
The first hedge fund manager to bet against Akman was Daniel
Loeb's analysis painted a different picture of Herbalife - one
of a viable business with growth potential. Loeb started buying
up the stock, and then publicly shared his views.
Carl Icahn followed suit a couple months later, promoting his
own pro-Herbalife outlook. And most recently, George Soros
acknowledged his long position in Herbalife. Once Loeb and Icahn
went public, Herbalife shares whipped back, and have since pushed
forward to the mid-60s.
Herbalife's price is being sent higher, thanks to short
sellers who are covering their positions. Additionally, new long
investors who are following Loeb, Icahn, and Soros are buying the
And Bill Ackman is paying the price. His Herbalife bet has
resulted in a $400 million loss. Ackman says that hasn't covered
his short position.
So what should investors do when a Herbalife situation
arises? There's an opportunity, but the reward of the
opportunity must be balanced against the risk.
I'll concede that I avoid short-selling for the reasons
discussed today. Yes, it was possible to make a quick profit by
shorting after Ackman shared his position. But that opportunity
was short lived.
Investing for the long-term is also not a sure thing. Had Loeb
and Icahn not stepped forward with their support, Herbalife
shares would likely be trading considerably lower than they are
What should you do if you own an investment that comes under
the glare of the public spotlight? My best advice is to hold firm
and reevaluate your investment thesis. Don't assume the big-name
investors understand the situation any better than you.
I speak from experience. Two
High Yield Wealth
recommendations were targets of short sellers. These sellers
shorted the stocks and then talked up their positions on the
My response was simply to review my analysis, which remained
valid. I neither sold nor bought. I simply stood pat. And shares
of both companies have since recovered.
I never blindly follow the actions of a famous investor,
because I never know of his next move (which will be made long
before you find out). Daniel Loeb treated Herbalife as a trade,
and quickly closed his position. Icahn and Soros appear to have
longer-term commitments, but you can't be sure.
When a drama like Herbalife comes along, I prefer to remain on
the sidelines and enjoy it from afar. But if I find myself part
of the drama, my analysis for being there directs my actions.